Article

Note: Pursuant to a contract, Kone Elevator (H.K.) LTD (Applicant/Elevator Maintenance Company) provided "a bank guarantee in the form of a Performance Bond ...issued by the Standard Chartered Bank (Hong Kong) Limited" [Guarantor] to cover disputes regarding performance of maintenance services in favor of Citybase Property Management LTD (Beneficiary/Owner). "The contract stated that 'If there shall be issues that cannot be agreed before expiry of the Contract, then the [Beneficiary/Owner] shall have the right to deduct from the bank guarantee the sum in disputes.'" [¶ 7] Pursuant to takeover provisions in the contract, Replacement Company took over maintenance when the contract ended and promptly reported significant failures in maintenance

When Applicant/Elevator Maintenance Company failed to correct these problems, Beneficiary/Owner authorized Replacement Company to undertake repairs on 1 August 2008 wrote Guarantor "stating that they 'would like to execute' the Performance Bond for the amount of HK$ 844,940.00 because [Applicant/Elevator Maintenance Company] had allegedly 'failed to complete the required maintenance duties under [the Contract] during 1 July 2006 to 30 June 2008'". [¶ 18] On 16 Sept 2008, Beneficiary/Owner informed Guarantor that it "... decided to execute the [Performance Bond] based on the professional advice from [Replacement Company] and requested to draw $ 771,400 from the Performance Bond." [¶ 23] On 29 Sept 2008, Guarantor sought further details and evidence supporting the demand. Upon receipt of this information, Guarantor paid the amount to Beneficiary/Owner and debited Applicant/Elevator Maintenance Company's account.

Applicant/Elevator Maintenance Company then sued Beneficiary/Owner to recover the proceeds and damages for wrongfully drawing on the bank guarantee. The Hong Kong Court of First Justice, Won, Recorder, entered judgment in favor of Applicant/Elevator Maintenance Company for $ 645,260.

The Recorder ruled that "[Beneficiary/Owner] was entitled to claim loss against [Applicant/Elevator Maintenance Company] in respect of the Admitted Items, and its loss was represented by the corresponding amounts that it paid to [Replacement Company] for carrying out the rectification works." [¶ 138] After the Recorder ruled that many of the items were not allowable, he construed the contract to permit any amount in dispute to be drawn, but ruled that Beneficiary/Owner had to repay any amount not permitted.

Applicant/Elevator Maintenance Company argued that Beneficiary/Owner was not entitled to draw on the Performance Bond because Applicant/Elevator Maintenance Company did not breach the contract.

Beneficiary/Owner argued that the Performance Bond entitled it to retain all proceeds. Beneficiary/Owner argued that this result followed because the Performance Bond was "conditional" exempting Beneficiary/Owner from having to account for any overpayment in the drawing.

The Performance Bond provided "NOW THE CONDITION of this Bond is such that if the [Applicant/Elevator Maintenance Company] shall duly perform and observe all the terms, provisions, conditions and stipulations of the Contract on the [Applicant/Elevator Maintenance Company] part to be performed and observed according to the true purport intent and meaning thereof or if on default by the [Applicant/Elevator Maintenance Company] the Surety [Guarantor] shall financially satisfy and discharge the damages sustained by [Beneficiary/Owner] thereby up to the amount of the above-written Bond then this obligation shall be null and void but otherwise shall be and remain in full force and effect... ."(¶117)

The Recorder "readily" accepted "that the Performance Bond, in these terms, is a conditional bond. In terms, the bond is not a 'single' or 'on demand' bond (under which payment is made simply upon the presentation of a demand, without any other conditions)." (¶118) The Recorder noted that the "Performance Bond was couched in archaic language, and it is indeed surprising that bonds couched in such language are still being used in 21st century Hong Kong." (¶119) He stated that because the Performance Bond is conditional, "Payment under the bond is conditional upon 'default' by the [Applicant/Elevator Maintenance Company] and 'damages sustained' by [Beneficiary/Owner]." (¶120) The Recorder cited the Court of Appeals in Tins' Industrial Co. Ltd v Kono Industrial Ltd [1998] 2 HKLR 36, at 42, for the proposition that "liability under such a bond is only in the nature of 'secondary liability'" (¶121)

The Recorder further stated that "As the underlying contract is relevant to liability under the Performance Bond, [Guarantor] could not, when presented with a claim by [Beneficiary/Owner] under the bond, ignore the provisions of ...the Contract. That clause ... expressly provided that where there were issues that could not be agreed before the expiry of the Contract, [Beneficiary/Owner] would have the right to deduct from the bank guarantee the sum in disputes."(¶122)

The Recorder also observed, "although the Performance Bond is a conditional one, when the bond is read and construed together with the underlying contract, the only condition for payment, in effect, is the mere existence of unagreed issues between [Beneficiary/Owner] and [Applicant/Elevator Maintenance Company] that have given rise to a 'sum in dispute'. This still would not make the Performance Bond an unconditional one, but one very close to it. The condition is easy to satisfy... nothing more is required other than the existence of some unresolved issues between [Applicant/Elevator Maintenance Company] and [Beneficiary/Owner] that give rise to a 'sum in dispute.' As I pointed out earlier, it is clear that insofar as Clause 30 gives [Beneficiary/Owner] a right to obtain payment of any sum in dispute, such a right can only be a right in the interim pending resolution of the dispute. In the absence of some clear words in the Contract to a different effect, it must be intended that after the dispute has been resolved, there should be an accounting between the parties."(¶¶125 & 126)

The Recorder then noted, "there is nothing in the Contract in this case to exclude the implication ... that there would be an 'accounting' between the parties when the dispute between them is resolved and their rights and obligations finally determined."(¶130)

Comment:

1. Characterization, "bank guarantee"; Conditional/unconditional. This opinion is another contribution to the unsatisfactory jurisprudence surrounding demand guarantees. This "bank guarantee in the form of a performance bond" is found by the judge to be "conditional" although the only condition is the existence of a dispute. The judge observes that such a condition would not make it unconditional "but very close". Since letter of credit type (independent undertakings) are conditional on the timely presentation of complying documents, it is difficult to know what is meant by the distinction between "conditional" an "unconditional".

2. Independence. If the undertaking is not independent, it is difficult to understand the question of damages. The guarantor should be able to excuse its obligation by virtue of the principal's defenses and the principal requesting the guarantee should be able to recover any excess proceeds. The question decided by the court treats the undertaking as if it was independent, whatever its categorization. If the guarantor must pay and cannot excuse itself on the basis that the funds are not due, it is hard to understand what is meant by independence.

3. Excess Proceeds. If the undertaking is independent, as the analysis (but not the characterization) treats it, the question addressed by the opinion is difficult, namely whether the beneficiary of an independent undertaking can retain excess proceeds.

4. Exchange of Communications. Guarantor and Owner exchanged communications before the drawing and Guarantor asked owner to supplement its claim. There should be concern whether such communication constitutes a refusal under any applicable practice rules.

Text: Contract
"The [Applicant/Elevator Maintenance Company] shall provide bank guarantee of a sum of TWELVE MONTHS' MAINTENANCE CHARGE to settle any claim in full for any loss due to malpractice of comprehensive maintenance included in the Contract. The validity of this guarantee shall cover the contract period and 3 months after expiry of contract. If there shall be issues that cannot be agreed before expiry of the Contract, then the [Beneficiary/Owner] shall have the right to deduct from the bank guarantee the sum in disputes." (¶ 7)

Text: Performance Bond
"NOW THE CONDITION of this Bond is such that if the [Applicant/Elevator Maintenance Company] shall duly perform and observe all the terms, provisions, conditions and stipulations of the Contract on the [Applicant/Elevator Maintenance Company's] part to be performed and observed according to the true purport intent and meaning thereof or if on default by the [Applicant/Elevator Maintenance Company] the Surety [Guarantor] shall financially satisfy and discharge the damages sustained by [Beneficiary/Owner] thereby up to the amount of the abovewritten Bond then this obligation shall be null and void but otherwise shall be and remain in full force and effect..." (¶ 117)

[JEB/rdp]

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